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Dynamic preferences for popular investment strategies in pension funds

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  • Carole Bernard
  • Minsuk Kwak

Abstract

In this paper, we characterize dynamic investment strategies that are consistent with the expected utility setting and more generally with the forward utility setting. Two popular dynamic strategies in the pension funds industry are used to illustrate our results: a constant proportion portfolio insurance (CPPI) strategy and a life-cycle strategy. For the CPPI strategy, we are able to infer preferences of the pension fund’s manager from her investment strategy, and to exhibit the specific expected utility maximization that makes this strategy optimal at any given time horizon. In the Black–Scholes market with deterministic parameters, we are able to show that traditional life-cycle funds are not optimal to any expected utility maximizers. We also prove that a CPPI strategy is optimal for a fund manager with HARA utility function, while an investor with a SAHARA utility function will choose a time-decreasing allocation to risky assets in the same spirit as the life-cycle funds strategy. Finally, we suggest how to modify these strategies if the financial market follows a more general diffusion process than in the Black–Scholes market.

Suggested Citation

  • Carole Bernard & Minsuk Kwak, 2016. "Dynamic preferences for popular investment strategies in pension funds," Scandinavian Actuarial Journal, Taylor & Francis Journals, vol. 2016(5), pages 398-419, May.
    • Handle: RePEc:taf:sactxx:v:2016:y:2016:i:5:p:398-419
    DOI: 10.1080/03461238.2014.954606
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    Cited by:

    1. Ng, Kenneth Tsz Hin & Chong, Wing Fung, 2024. "Optimal investment in defined contribution pension schemes with forward utility preferences," Insurance: Mathematics and Economics, Elsevier, vol. 114(C), pages 192-211.
    2. Raquel M. Gaspar & Paulo M. Silva, 2023. "Investors’ perspective on portfolio insurance," Portuguese Economic Journal, Springer;Instituto Superior de Economia e Gestao, vol. 22(1), pages 49-79, January.

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